What is tax loss harvesting and how can I make use of it?

I was reading this post on Z-connect and I couldn’t fully grasp the concept. Was wondering if someone could explain the concept and how can I leverage it while paying taxes.

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Few things to know firstly, suggest you to go through this for details: https://zerodha.com/varsity/module/markets-and-taxation/

In India since long term capital gains is exempt of taxes, you cannot setoff any long term capital losses. So what it means is that if you bought stock for 1lk and sold it for 2lks after 1 year, there is no taxes to pay. If you bought stock at 2lks and sold at 1lk and booked a loss of 1lk, you can’t adjust this loss to any other gain.

Taxes on short term capital gain (STCG) is 15%. So if you held stock for less than 1 year and sold it, you have to pay 15% of the gain as taxes. If you make a short term capital loss (STCL), this can be adjusted with the short term capital gain and 15% of the net gain has to be paid as taxes.

So on stock A you have STCG of 1lk, on stock B you have STCL of 50k, you pay taxes only on 50k.

Now assume end of financial year on say 29th March, you had 2lk of STCG. You are holding stocks where there is a unrealized loss of Rs 1lk. If you don’t do anything, you end up paying 15% of 2lks or 30k as taxes. But if you realized the 1lk losses by selling it in the market, your net profit for the year is only Rs 1lk. So you pay 15k as taxes, a saving of Rs 15k. Once you have sold these stocks to realize the loss, you can buy it back again once the stock moves out of your demat account. It is a grey area, but some people even sell it on one exchange and buy it on another (stocks move out of your DP) same day.

This act of booking your loss to save on some money is called tax loss harvesting.

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@nithin @Quicko I am NOT an intraday trader. I have STCG for 2020-21. I had active positions where I had short term losses. I sold the security and bought it the same day. Is that allowed for offset of STCG ?

If you bought and sold the same number of shares, and did both the selling and the buying using the same trading account then, as far as I know, this will be considered an intra-day trade. This is because when you do this no share moves out of your demat account: the settlement happens in the broker’s (or exchange’s; I am not entirely clear about this) books. They cancel out your purchase with your sale, so that no shares have to be taken out of, or put into, your demat account.

Such transactions do not qualify for capital gain/loss computation, as far as I know. Let us wait for the experts to tell us the correct thing, though.

To make sure that your purchase/sale counts towards capital gain/loss, the safe thing is to wait for a couple of days after the first transaction, to do the second transaction. Since settlement happens on day T+2, this will ensure that the shares move out of/into your demat account. To make this work for tax purposes you may have to do the first transaction a number of days before March 31.

If you sold and bought it back the same day, then it is an intraday or speculative trade. You can’t consider that trade as an exit trade for your holdings. You would have to wait till the stock moves out of your Demat. So sell it and buy it back after 2 days.

Btw, in the US it is called a wash sale if you buy back the same stock within 30 days just with the intent to harvest losses, and is prohibited. So when doing tax-loss harvesting in the US, folks buy identical stocks/ETFs and not the same security.

In India, there isn’t an explicit rule prohibiting this.

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Alternatively, one can invest the LTCG beyond 1L in a residential property or land under section 54F, or open a CGAS account under section 54 to defer the LTCG taxation by maximum 3 years and if the investor has any business loss for that year, it can be set off against the same.

thanks @nithin